The Century-Old Secretive Banking Elite

A must-read article appeared in today's New York Times: "A Secretive Banking Elite Rules Trading in Derivatives" The NYT, despite numerous examples of leftward media bias and abandonment of objective journalism, is no grocery store tabloid. This story will confirm the worst fears of some conspiracy theorists. Jim Sinclair comments: "What has become of Western Financial Society that it needs to be run by secret cabals? What has become of the people that this can be discussed in the light of day and nobody really cares." I must add that, as an antitrust lawyer, I agree with the legal experts cited in the article that what is described is an illegal conspiracy under the Sherman Act. But bankers are uniquely insensitive to the legality of their actions. After all, the Fed is a cartel and was openly chartered as such. I digress with a little history lesson:

Legal tender greenbacks printed to support the Union war effort established a national currency after 1862; but that did not change the fact that some bankers occasionally underestimated depositors’ demand for money, causing bank panics and runs on the bank. And as commerce grew, the seasonal demand for credit became a larger and larger problem. Prudent bankers simply didn’t have enough money to lend out to businessmen for growth and to farmers at planting time. That was either a lost business opportunity for banks or it encouraged imprudent bankers to lend out more than they should, placing the bank’s stability at risk. It also created a liquidity problem in an economy that was growing increasingly sophisticated and an environment in which business could grow faster with outside financing. The bankers were in a straight jacket imposed by the market which required the banks to have a solid reputation and adequate reserves 100% of the time. And bankers felt a need to safely escape those strictures, which limited the banks’ ability to lend out more money and thus their ability to make more money on banking.

The Federal Reserve System

By 1910 the situation had begun to wear on the banks. And so, some influential people in banking and finance conceived of a central bank where they could pool their resources, to be drawn upon in emergencies. Key influential banking magnates met secretly in Jekyll Island, Georgia, to agree to and create a banking cartel. The cartel was modeled after the European banking cartels that existed at the time. Nelson Aldrich, the Senate Republican Whip and father-in-law of John D. Rockefeller, Jr., was the sole non-banker at the meeting. He described the idea as “not a bank, but a cooperative union of all banks of the country for definite purposes.” It went beyond the notion of private cartels such as we know today, like the DeBeers diamond cartel or OPEC. The notion was to make it a government imposed cartel like the Interstate Commerce Commission and later government agencies such as the Civil Aeronautics Board and Federal Communications Commission, all of which were chartered to give government and its proxies the exclusive right to set prices and allocate markets and resources for private corporations. A. Barton Hepburn of Chase National Bank speaking in support of the legislation said, “The measure recognizes and adopts the principles of a central bank. Indeed, if it works out as the sponsors of the law hope, it will make all incorporated banks together joint owners of a central dominating power.” Thus, in 1913 the Federal Reserve System was born. Unlike the CAB and FCC, however, the Fed is a private central bank owned by its members but imposed on them by law

"Dominating." Hmmm. To be sure.  And that is how the key players understand their role. They justify in their own minds that what they do is patriotism: they preserve the Republic. (Their bonuses are only incidental to a greater good.) But that is clearly a rationalization.

Please remain alert to Congressman Paul's expose in the coming months of the Fed and its minions.

There is no nefarious intent here.  The banks have not set as their goal to own you or your assets, or to run the economy.  They only want to make money and conserve their capital, like any other good business.  But they need to make money honestly, without the application of  "force" (meaning ultimately the guns of the government) to coerce people into transactions (or to avoid them).

Dr. Paul advocates the gold standard, which applied to our money less than a century ago.  That ideal cannot practicably be implemented in today's world economy although it can be approximated.  The point is that we, indeed every nation, need a currency that adheres to an objective standard that is beyond the control of politicians and banking interests that use their inside influence to profit from advantages they gain from a special relationship with the government and its proxies.

A Perspective on the Mortgage Mess

Here is a succinct perspective on the mortgage mess.

1. Ultimately, the people who didn't pay their mortgages will lose their homes.

2. Ultimately, the losses resulting from mortgage defaults will have to show up on someone's books; but they will not show up all at once. Reports of the losses will be bled out quarter by quarter on the "frog in a pot theory" * so that the market is not shocked at the magnitude of the problem.

3. People who bought foreclosed properties and thought they had clear title will find, in significant numbers of cases, that they do not in fact have clear title to their homes -- because it is not clear who had a right to foreclose in the first place or the party who foreclosed and sold the property actually had no right to do so. Either could give rise to the uncomfortable situation in which two (or more) people claim title to the same property.

4. Ultimately, who owns any particular mortgage and note will be sorted out. That process will be tedious, lengthy and contentious as the falsifications, mistakes and systemic flaws surface and reveal that more than just homeowners will lose.

5. Many investors, including not only private parties but also public and private pension funds and corporate treasurers, who thought they bought mortgage-backed securities will find that, as a consequence of the systemic flaws in the MBS creation process, their securities were not in fact mortgage-backed, reducing their investment to an unsecured note of substantially lower value than they thought they had.

6. The parties in every step of the MBS transactions who insured their bonds with Credit Default Swaps -- will call upon their CDS counterparties to cover their losses arising from the mess. Unlike regular insurance, however, CDS counterparties do not ordinarily set aside reserves to cover their CDS obligations. (This ignores the additional problem that because CDS obligations are traded many times over, it is difficult to identify the real counterparty.) The likely tidal wave of CDS demands cannot be met from the capital of the counterparties (usually large banks, investment banks and hedge funds).  And the ensuing chaos from the uncertainty of who owns what will delay and defy resolution.

7. The investors will sue the CDS counterparties, MBS creators, sellers and brokers, the rating agencies, the accountants and the lawyers involved in creating the flawed instruments. Lawyers on all sides will get rich; everyone else will lose. The magnitude of the problem is measured in the $Trillions.

8. The Fed -- which has shown no reluctance to bail out banks, investment banks, hedge funds and commercial businesses by loaning printed money or by buying garbage at par -- will continue to backstop the system. Ultimately, while it could forestall another crash, the money printing and additional credit facilities could cause general price inflation or another bubble somewhere it is not wanted (the law of unintended consequences), either of which will end very badly for the economy. The public is becoming aware of the Fed's actions and is increasingly unhappy that the perpetrators of fraud are escaping prosecution and, instead, are receiving bonuses with public money while the consequences of their acts cause unemployment and decimation of the value of the one asset in which most citizens have invested their meager savings. With Ron Paul as the head of the Monetary Policy Subcommittee, the fireworks are likely to be significant. The efforts of the banks and the Fed to suppress any and all information in this regard will be huge. Fortunately, there is an internet -- where actual events (not just the opinions of bloggers) can be aired and facts checked -- that is, until the internet itself is constrained as a "security risk." (Shut those bloggers up for goodness sake! The truth will kill us all -- Joe Sixpack cannot possibly handle the truth: witness what he did in the last election!)

9. The stock and bond markets are anticipating all of the above. Real interest rates are starting to rise despite the efforts of the Fed to suppress them. And the stock market has recovered, more or less, from its 2008 lows, anticipating (somewhat scizophrenically) that the Fed's efforts to keep the economy afloat will restore consumer confidence.

10. The States, which collect transfer taxes on each real estate transaction (and which are in dire financial straits), are very, very unhappy that the banks created a system in which they tried to evade paying those taxes, even though title to local real estate changed multiple times.

11. Efforts to achieve a global settlement that would validate the flawed system, pardon the frauds, and compensate the States, investors, CDS counterparties and banks for their losses, will be very difficult if not impossible to achieve.

12. Because the underlying failures of the system have not been rectified and the health of our financial institutions restored, the economy and the stock market's hope for a substantive recovery remain fragile. You need to carefully (daily) monitor your investments and the financial news.


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*The frog in a pot theory holds that if you put a live frog in a pot of cold water and gradually increase the heat, the frog will stay in the pot until it is cooked. But if you drop a frog in a pot of boiling water, it will jump out immediately.

Election Day 2010

Thu, November 4, 2010 7:05:30 PM

Between Tuesday's elections and Wednesday's announcement by the Federal Reserve that it will print more than half a trillion dollars, the Fed announcement is by far the most important. 

The new Congress will be able to do little to reverse the damage done to our way of life by the social democrats and progressives to destroy the middle class -- although if the Republicans play their cards right, they might be able to shine the light of day on corruption at the highest levels and Democrat attempts to unravel the American Revolution.  If successful, they could set the stage for regime change in 2012.  It remains to be seen.  The establishment in both parties see the Republican victory as a reflection of the state of the economy.  Neither see it, really, as a demand from the people for less government, lower taxes and more personal responsibility -- the message of the Tea Party.  Fundamental alteration of the trend in the other direction will not happen.

The Fed announced Wednesday that it will print $600 Billion (ephemistically termed "Quantitative Easing" -- "QE-2")  in new money on top of the $300 billion+ ("QE-1") the central bank printed last year in a vain attempt to boost the economy.  While that will make the dollar worth less and might suppress interest rates for a while, the actions will simply postpone the day of reckoning and impose a stealth tax on the little old ladies on fixed incomes and transfer hard-earned savings to the big banks so they can pay obscene bonuses to their thieves for thievery.  As you consider the actions of the Fed, remember that the Federal Reserve is a creature chartered by the banks, for the banks. Those with a thirst for detail should read The Creature from Jekyll Island. 

The Fed's attempt to print us out of a recession and inflate the value of housing back to bubble levels is extraordinarily risky.  Debasing the currency to fund the government has been tried repeatedly for thousands of years and, without exception, has been unsuccessful -- repeat: without exception it has been unsuccessful throughout history.  The result always is either hyperinflation as more money is printed to chase the elusive goal, or a depression resulting from a contraction in the money supply when the monetary authorities realize that the money supply needs to be reigned-in.  In either event, it will not end well although a depression is preferable because hyperinflation is much more destructive.  See Inflation, Deflation and Chaos.  Many sound thinkers are aghast at the Fed's continued money-printing in an effort to inflate assets and the stock market.  Consider the following:

Must Watch: David Stockman Says The Fed Is Injecting High Grade Monetary Heroin Into The Financial System

Inflationary Thursday - Benny Drops the Big One!

QE2 - The Day After: Entire World Blasts Deranged Madman's Uncheckable Insanity

A Minskian Explanation of the Causes of the Current Crisis

Hyperinflation is not a monetary phenomenon.  It is a political phenomenon that occurs when a population loses faith in its currency -- and flees the currency. The change happens suddenly and in a panic as those who had been in denial realize that the game is over. When inflation occurs, one experiences a rise in prices and sees a deterioration in business performance as companies struggle to make a profit in that environment.  In an inflationary environment, commodities provide the most opportunity for gain -- stocks and bonds, less so.  But when hyperinflation begins, there is a rush to the exits, the so-called "fire in the disco" phenomenon, as everyone immediately tries to exchange the currency for something intrinsically valuable such as ounces of gold, real estate, diamonds or shares in a viable company. Stocks do well but the economic chaos makes most of them risky and regular folks have nowhere to turn but the historically proven assets: one's own home (pay off the mortgage with debased dollars) or precious metals -- silver, gold and platinum.  In the short term, survival strategies (water, food shelter, energy and personal protection)  become important.  In the longer term, how to survive and benefit from the chaos is the most important issue that should preoccupy cool heads.

Be prepared enough not to be subject to or panicked by huge market downdrafts or currency events.  But be alert for them and understand why and how they happen.  If you see them happening, quickly implement the plan you have devised to respond to these events -- for they surely will occur -- two years hence, three years, five or ten.  They will happen as surely as night follows the day.

I would be remiss if I did not discuss the injustice of the official theft that inflation represents.

In the Second Legal Tender cases Justice Bradley explained in salutary terms how printing money works as an "imperceptible tax" to finance war by invisibly spreading the financial pain:

In this country, the habit had prevailed from the commencement of the eighteenth century, of issuing bills of credit [paper money]; and the revolution of independence had just been achieved, in great degree, by the means of similar bills issued by the Continental Congress. These bills were generally made a legal tender for the payment of all debts public and private, until, by the influence of English merchants at home, Parliament prohibited the issue of bills with that quality. This prohibition was first exercised in 1751, against the New England colonies; and subsequently, in 1763, against all the colonies. It was one of the causes of discontent which finally culminated in the Revolution. Dr. Franklin endeavored to obtain a repeal of the prohibitory acts, but only succeeded in obtaining from Parliament, in 1773, an act authorizing the colonies to make their bills receivable for taxes and debts due to the colony that issued them. At the breaking out of the war, the Continental Congress commenced the issue of bills of credit, and the war was carried on without other resources for three or four years. It may be said with truth, that we owe our national independence to the use of this fiscal agency. Dr. Franklin, in a letter to a friend, dated from Paris, in April, 1779, after deploring the depreciation which the Continental currency had undergone, said: 'The only consolation under the evil is, that the public debt is proportionately diminished by the depreciation; and this by a kind of imperceptible tax, every one having paid a part of it in the fall of value that took place between the receiving and paying such sums as passed through his hands.' He adds: 'This effect of paper currency is not understood this side the water [i.e., Europe]. And indeed the whole is a mystery even to the politicians, how we have been able to continue a war four years without money, and how we could pay with paper, that had no previously fixed fund appropriated specially to redeem it. This currency, as we manage it, is a wonderful machine. It performs its office when we issue it; it pays and clothes troops, and provides victuals and ammunition.' In a subsequent letter, of 9th October, 1780, he says: 'They [the Congress] issued an immense quantity of paper bills, to pay, clothe, arm, and feed their troops, and fit out ships; and with this paper, without taxes for the first three years, they fought and battled one of the most powerful nations of Europe.' The Continental bills were not made legal tenders at first, but in January, 1777, the Congress passed resolutions declaring that they ought to pass current in all payments, and be deemed in value equal to the same nominal sums in Spanish dollars, and that any one refusing so to receive them ought to be deemed an enemy to the liberties of the United States; and recommending to the legislatures of the several States to pass laws to that effect." 79 U.S. 457, 558. [Footnotes omitted.]

Justice Clifford, acknowledging the above in his dissent, pointed out that the "wonderful machine" described by Dr. Franklin had a dark side:

. . . these measures of violence and terror [i.e., making those refusing to take the Continental dollar enemies to the liberty of the United States], so far from aiding the circulation of the paper, led on to still further depreciation. New emissions followed and new measures were adopted to give the paper credit by pledging the public faith for its redemption. Effort followed effort in that direction until the idea of redemption at par was abandoned. Forty for one was offered and the States were required to report the bills under that regulation, but few of the old bills were ever reported, and of course few only of the contemplated new notes were issued, and the bills in a brief period ceased to circulate, and in the course of that year quietly died in the hands of their possessors. [Footnotes omitted.]

James Madison, the chief architect of our Constitution, understood what inflation means to ordinary people.  He discussed it in The Federalist, No. 44 in discussing the Constitutional provision denying the states the power to emit bills of credit (paper money):

The extension of the prohibition to bills of credit [to the States] must give pleasure to every citizen in proportion to his love of justice, and his knowledge of the true springs of public prosperity. The loss which America has sustained since the peace, from the pestilent effects of paper money, on the necessary confidence between man and man; on the necessary confidence in the public councils; on the industry and morals of the people, and on the character of Republican Government, constitutes an enormous debt against the States chargeable with this unadvised measure, which must long remain unsatisfied; or rather an accumulation of guilt, which can be expiated no otherwise than by a voluntary sacrifice on the altar of justice, of the power which has been the instrument of it. In addition to these persuasive considerations, it may be observed that the same reasons which shew the necessity of denying to the States the power of regulating coin, prove with equal force that they ought not to be at liberty to substitute a paper medium in the place of coin.  . . . The power to make any thing but gold and silver a tender in payment of debts, is withdrawn from the States, on the same principle with that of striking of paper currency.

The mainstream media does not spend enough time exposing the inflation that impacts most of us.  It is a cruel hoax on retired people who contributed for decades to Social Security to be told that the cost of living on which their retirement payments are indexed exclude food and energy.  The pretext is that these two items are too volatile.  But the facts are that inflation overall, especially in these two areas, is  increasing. See http://www.zerohedge.com/article/quick-glance-real-world-inflation.

Understand what is going on, folks.  Protect yourselves and your own.  Be alert, be nimble and be quick.  You are amongst predators from every imaginable direction.

The Military Ethic

Douglas MacArthur was arguably one of the greatest Generals in history.  Even though his wars were not wars of aggression, he ranks strategically with Napoleon, Julius Caesar, Alexander and Genghis Khan.  And, he was a master of public relations. His successes in the face of great odds, his personal charisma and his way with the press corps made him a popular figure back home.  And he was a wise leader, even in government assignments:  As governor of Japan after the War, he demonstrated a model for nation-building that the U.S. administrators in Iraq have ignored at their peril.

In a speech at West Point in 1962, he lectured the Cadets about their role as military officers, cautioning them to stick to their knitting and avoid participating in controversies that were the province of the civilian leaders:

. . . your mission remains fixed, determined, inviolable—it is to win our wars. Everything else in your professional career is but a corollary to this vital dedication. All other public purposes, all other public projects, all other public needs, great or small, will find others for their accomplishment; but you are the ones who are trained to fight; yours is the profession of arms—the will to win, the sure knowledge that in war there is no substitute for victory; that if you lose, the nation will be destroyed; that the very obsession of your public service must be Duty—Honor—Country. Others will debate the controversial issues, national and international, which divide man’s minds; but serene, calm, aloof, you stand as the nation’s war guardian, as its lifeguard from the raging tides of international conflict; as its gladiator in the arena of battle. For a century and a half, you have defended, guarded, and protected its hallowed traditions of liberty and freedom, of right and justice. Let civilian voices argue the merits or demerits of our processes of government; whether our strength is being sapped by deficit financing, indulged in too long; by federal paternalism grown too mighty; by power groups grown too arrogant; by politics grown too corrupt; by crime grown too rampant; by morals grown too low; by taxes grown too high; by extremists grown too violent; whether our personal liberties are as thorough and complete as they should be. These great national problems are not for your professional participation or military solution. Your guidepost stands out like a tenfold beacon in the night—Duty—Honor—Country.

A decade before, after more than half a century of active duty, the very popular five-star General was fired from his final military post and retired by the President of the United States because MacArthur publicly challenged the President's decision on the strategy for the Korean War.  What was he thinking!? History will likely conclude that he took a risk on the chance that his strategy was correct and that it ultimately would be adopted.  (The strategy was to create a nuclear hot zone by exploding nuclear bombs across the northern border of Korea to block a Chinese invasion.)

A very important ethic exists in the United States military -- that the military is subject to absolute civilian control by virtue of the President's position of Commander in Chief of the armed forces, a circumstance implicitly recognized by MacArthur's comments in 1962.  While the President's role can be abused by inexpert micromanagement, such as Lyndon Johnson's making tactical decisions during the Vietnam War, that is the President's prerogative -- and he will be held accountable by the people, as was President Johnson.

Which brings us to the current indiscretion of General McChrystal.  The military academies teach moral lessons using many techniques --  the case method, strategic studies, essays and counsel of iconic leaders, poems, and quotations such as "Where principle is involved, be deaf to expediency" and "Discretion is the better part of valor."  General McChrystal seems to have failed to balance the latter two with the notion that he is subordinate to the Commander in Chief.  As a junior officer, he would not have dared to publicly challenge his military superiors as he did with his Commander in Chief.  It is no different now that he has four stars on his shoulders.  What was he thinking!?

While as a citizen I might disagree with the U.S. government's decisions to send our troops into Iraq and Afghanistan, I strongly support the important principle that the elected representatives of the people, within their Constitutional limitations, should control the federal military, who should salute smartly and say, "Yes sir!"

As I write, General McChrystal is on his way to Washington to face his Commander in Chief. If he is worthy of his four stars, he will retire forthwith.  And then he can criticize the President's decisions, as I do, but not before.

[Update July 9, 2010]  Paul Hollrah, Senior Fellow at the Lincoln Heritage Institute provides an answer to the question, "What was he thinking!?"  See The General and the Community Organizer.

AIG Bailout Avoided 25% Unemployment?

Henry Paulson in testimony before a House Committee today asserted that the bailout of AIG avoided 25% unemployment.  While that remains to be seen, as unemployment is still rising, Paulson's statement reminds me of the ridiculous "jobs saved and created" scam that the Administration tried but subsequently withdrew.

Democratic Congressman Stephen Lynch was more credible when he chewed out Treasury Secretary Geithner for the AIG bailout because Geithner failed to represent the American people.  He compared the Bear Sterns bailout, in which the shareholders of Bear Sterns received only 2% on the dollar, while Goldman Sachs, AIG's counterparty in credit default swaps, received 100% on the dollar.  The implication is that Geithner was trying to secretly funnel as much cash as possible to big Wall Street firms, an implication that finds further support in the Fed's election not to guarantee AIG's credit default swaps.  See Why Did the Fed Board of Governors Nix Guaranteeing AIG's CDS?

But Rep. Lynch is comparing apples to oranges.  The Bear Sterns "bailout" was a shotgun marriage arranged with J.P. Morgan.  It was J.P. Morgan that was bailed out because J.P. Morgan was counterparty to much of Bear Sterns debt.  So the two bailouts are in fact comparable.  Rather than chewing out Geithner for not negotiating a good deal, Rep. Lynch should have chewed him out for failure to be forthcoming about where the money was really going in both cases.

Rep. Lynch's ire is a smokescreen designed to identify a scapegoat.  In their desperation to win public favor, the Dems are throwing Geithner to the wolves.

More Propaganda

As part of the government's continuing efforts to shape public perspectives on the economy, the SEC has proposed to limit short sales.

As Reggie Middleton notes (free registration required), this renewed effort to constrain the free actions of the stock market not only will inhibit the discovery of true equilibrium prices, but will mask activities, such as fraud, that deserve scrutiny.  The SEC is once again demonstrating, as it has done in its continuing conscious failure to prosecute Paulson, Bernanke, and Geithner, that it is just another tool of the Obama Administration's propaganda machine, rather than the independent entity that it purports to be.

Simple, Straightforward, Succinct

The Cato Institute just posted on Facebook a 10-point Libertarian suggestion for the State of the Union Address:

1. Abandon Obamacare
2. Forget Cap and Trade
3. Reject Card Check Bill
4. Withdraw from Iraq and Afghanistan
5. Legalize Drugs
6. Scrap tax code and replace with flat tax.
7. Expand free trade and immigration.
8. Stop bailouts
9. Cut spending
10. Cut spending
BONUS - Cut spending

 For those who prefer bullet points instead of lengthy dialog, there you have it.